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Tapping Your 401(k) for Personal Expenses – Episode 189

Tapping Your 401(k)

IRA Financial’s Adam Bergman discusses the many ways you can tap your 401(k) plan to pay for personal expenses.

Many people mistakenly think they can dip into their 401(k) plan whenever they feel like. They put their own money in, so why can’t they withdraw from it when they want? It’s simple, the government wants you to have money for retirement. Therefore, they penalize you when you take money from a retirement plan before you’re old enough. Further, most 401(k) plans won’t even let you take money out of the plan. This is different from IRAs, which you may tap into at anytime, so long as you pay the taxes due and an early withdrawal penalty. However, there are some ways to get much needed money from your 401(k), under the right circumstances. Tapping your 401(k) for hardship withdrawals is (usually) the only way to withdraw funds.

Tapping your 401(k) – Triggering Event

To get to your 401(k) funds, you could use a plan triggering event. This a situation that will allow you access to your funds without triggering the 10% penalty. The first one is when you reach age 59 1/2. While you probably won’t be retired by this time, you are allowed to withdraw 401(k) funds penalty-free. If you have a traditional plan, you will need to pay the taxes due on the withdrawal. On the other hand, if you have a Roth, no taxes are due on qualified withdrawals.

The next triggering event is if/when you part ways with the company that sponsors the plan. If you leave your job, you can either roll over the funds to a new 401(k) or an IRA, or you can use the money for personal expenses. If you are under age 59 1/2, you will still have to pay the 10% penalty and taxes.

The last one is if the plan is terminated by your employer. Obviously, if there no longer is a plan, you have the option to move your funds to a new plan, or simply take a distribution.

Other Ways to Tap Your 401(k)

Another way to get funds from your 401(k) is if you have a hardship withdrawal. If you are in dire straights, the IRS will allow you to take money from your 401(k). This means that you will have to show that you don’t have any other recourse to pay for these expenses. The IRS lists the hardship distribution rules which include the following:

  • Some medical expenses
  • Purchasing a primary residence
  • Higher education costs
  • Preventing foreclosure or eviction from primary residence
  • Funeral and/or burial expenses
  • Damage to principal residence due to natural disaster

Another way to tap your 401(k) is by taking on Substantial Equal Periodic Payments, or SEPP. This allows you to withdraw funds before you reach age 59 1/2. You must take these payments for five years, or until you reach that age, whichever is more. Failure to maintain the full length of the SEPP will result in penalties plus interest.

The 401(k) Loan

One last way to tap your 401(k) is by taking a 401(k) loan, if your plan allows it. You are allowed to borrow up to $50,000 or 50% of your account balance, whichever is less. You have five years to repay the loan and you must make payments quarterly. You will be charged interest on the loan of at least the Prime Rate, which is 5.25% as of August 15, 2019. However, the good news is that all interest is paid back to your 401(k), and not a bank.

Further, you can utilize the loan for whatever reason – pay off credit card debt, buy a new car, take a vacation, etc. But, you should never borrow from your 401(k) unless it’s an immediate need. Any money taken from the plan is no longer working for you. The more you have in the plan, the more compounding works for you.

Conclusion

While taking money from your 401(k) is not ideal, some times you don’t have a choice. As we just mentioned, never withdraw from any retirement plan unless you absolutely have to. Let the power of tax-deferral and compounding work for you. The IRS has these rules for a reason…so you don’t sabotage your retirement years. The above instances are the only times you should even consider touching your funds.

For more information about tapping your 401(k), please contact us @ 800.472.0646. Thanks for listening, and be sure to check out all of our podcasts.

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